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WHAT IS TECHNICAL ANALYSIS?

Technical analysis is a means of examining and predicting price movements in the financial markets, by using historical price charts and market statistics. It is based on the idea that if a trader can identify previous market patterns, they can form a fairly accurate prediction of future price trajectories.

It is one of the two major schools of market analysis, the other being fundamental analysis. Whereas fundamental analysis focuses on an asset’s ‘true value’, with the meaning of external factors and intrinsic value both considered, technical analysis is based purely on the price charts of an asset. It is solely the identification of patterns on a chart that is used to predict future movements.

What Does Technical Analysis Tell You?

Technical analysis is a blanket term for a variety of strategies that depend on interpretation of price action in a stock. Most technical analysis is focused on determining whether or not a current trend will continue and, if not, when it will reverse. Some technical analysts swear by trendlines, others use candlestick formations, and yet others prefer bands and boxes created through a mathematical visualization. Most technical analysts use some combination of tools to recognize potential entry and exit points for trades. A chart formation may indicate an entry point for a short seller, for example, but the trader will look at moving averages for different time periods to confirm that a breakdown is likely.

How to Use Technical Analysis

The core principle underlying technical analysis is that the market price reflects all available information that could impact a market. As a result, there's no need to look at economic, fundamental, or new developments since they're already priced into a given security. Technical analysts generally believe that prices move in trends and history tends to repeat itself when it comes to the market's overall psychology. The two major types of technical analysis are chart patterns and technical (statistical) indicators.

Chart patterns are a subjective form of technical analysis where technicians attempt to identify areas of support and resistance on a chart by looking at specific patterns. These patterns, underpinned by psychological factors, are designed to predict where prices are headed, following a breakout or breakdown from a specific price point and time. For example, an ascending triangle chart pattern is a bullish chart pattern that shows a key area of resistance. A breakout from this resistance could lead to a significant, high-volume move higher.

Technical indicators are a statistical form of technical analysis where technicians apply various mathematical formulas to prices and volumes. The most common technical indicators are moving averages, which smooth price data to help make it easier to spot trends. More complex technical indicators include the moving average convergence divergence (MACD), which looks at the interplay between several moving averages. Many trading systems are based on technical indicators since they can be quantitatively calculated.

Limitations of Technical Analysis

Technical analysis has the same limitation of any strategy based on particular trade triggers. The chart can be misinterpreted. The formation may be predicated on low volume. The periods being used for the moving averages may be too long or too short for the type of trade you are looking to make. Leaving those aside, the technical analysis of stocks and trends has a fascinating limitation unique to itself.

WHAT IS TECHNICAL ANALYSIS

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